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EMC and VMware, Once Threatened by Cloud Computing, Thriving Up There

Five years ago when investors first began hearing about cloud
computing, it looked like a big threat to EMC Corp. (
EMC
) and its 79%-owned, publicly-traded, software unit, VMware Corp.
(
VMW
).

But now, it looks increasingly clear that the two companies
have navigated the early days of the transition to the cloud, and
that they are well positioned to continue to thrive. The stock
prices of the two companies tend to move in lock-step, which
makes sense since the stake in VMware currently accounts for 55%
of EMC's market cap.

The two companies are currently involved in a complex
management pas-de-deux. EMC's chief operating officer, Pat
Gelsinger, this week moved to become chief executive officer at
VMware. Paul Maritz, a former Microsoft and EMC executive who has
been CEO at VMware since 2008, returned to EMC.

Maritz will be chief strategist for EMC, assisting chairman
and CEO Joseph Tucci. Tucci turned 65 this year and announced he
was delaying his planned December retirement. But outsiders note
that the 57-year old Maritz is well positioned to become CEO of
EMC.

By most measures, Maritz and Tucci both get good marks for
their companies' performance this year. While most big tech firms
have suffered in the worldwide slowdown, VMware revenue grew 24%
and EMC's rose 6.6% over the last 12 months.

VMware, with a trailing
PE ratio
of 51, is highly sensitive to any slowdown in its earnings
growth. Reflecting the value of VMware, EMC's
PE ratio
is 22, a nosebleed level compared to most enterprise hardware
companies.

It seems increasingly clear that VMware and EMC are well
positioned to benefit from the technology transition to cloud
computing. In fact, it could be argued that VMware, in particular
is driving the technology forward.

Cloud computing involves moving computing tasks to large,
hosted data centers where companies like Amazon (
AMZN
) and RackSpace (
RAX
) take care of operating the computers and software and cut costs
by sharing the infrastructure among many customers.

Those cloud operators tend to view computer storage (such as
EMC makes) and data center software (such as VMware provides) as
commodities, and they are big enough to build their own or buy it
at bargain-basement prices.

The technology threatened data storage giant EMC because it
meant that more and more companies would be storing their data in
cloud-computing facilities rather than inside their own data
centers. EMC's advanced technology and legendary direct-sales
force had long held sway with corporate CIOs.

It threatened VMware because companies shrinking their own
data centers needed less of VMware's virtualization software.
Ironically, VMware itself enabled the whole cloud-computing model
by figuring out a way to write software that created multiple
software servers running on each Intel hardware server. That was
attractive for companies that quickly discovered they could
control the growth of their own data centers. But it was only a
small step beyond for cloud hosts to develop ways to virtualize
servers for many different companies in much larger and more
economical cloud data centers.

But data centers haven't disappeared. Most big companies still
operate their own data centers for core operations. They worry
about security of tightly regulated data like health information
if it ends up in public clouds. Many are developing hybrid
strategies with some functions, like e-mail and application
development, in public clouds, and many applications still
running on virtual servers in their own data centers.

VMware has also cemented its dominance of the virtualization
market. Gartner estimates that a whopping 80% of virtualized
workloads run on VMware, despite competition from Microsoft and
open-source projects.

VMware under Maritz has spent the last three years building
and buying technology to create a virtualized data center. Its
recent acquisition of Nicira gives it a big foothold in the
potentially massive virtual networking market. It estimates that
it can now address a $50 billion annual market, up from just $20
billion a year ago.

Meanwhile, VMware recently reiterated that it continues to
expect 18% to 22% revenue growth in the current year to over $4.5
billion.

EMC, too, is well positioned to grow due to continued huge
increases in the amount of data being stored. This year, despite
the global IT spending slowdown, it anticipates full year revenue
of $22 billion, up 10% from 2011.

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